WASHINGTON (AP) -- Factory activity expanded in January at the fastest pace in nearly seven years, as manufacturers reported a sharp jump in new orders.

Still, builders spent less on projects in December, pushing annual construction spending down to a decade low.

The Institute for Supply Management, a private trade group, said Tuesday that its index of manufacturing activity rose last month to 60.8, from 58.5 in December. The sector has expanded for 18 straight months, and January's reading was the highest since May 2004. Any reading above 50 indicates expansion.

The manufacturing sector bottomed out at 33.3 in December 2008, the lowest point since June 1980.

Rising industrial output has been a key driver for the economy since the recession ended in June 2009. Tuesday's report shows the sector is still expanding at a healthy pace.

"Momentum is again building for this sector," said Thomas Duesterberg, the CEO of Manufacturers Alliance/MAPI, a trade group. "Manufacturing will continue to lead the recovery at least through mid-year."

Builders began work on fewer homes, shopping centers and other commercial real estate projects. Spending on public projects also declined, as state and local governments grapple with budget crises and federal stimulus dollars fade.

"If manufacturing is the best performing sector, construction remains the worst," said Paul Ashworth, an economist at Capital Economics.

Investors appeared to overlook the poor housing report. The Dow Jones industrial average jumped more than 115 points in midday trading.

Manufacturing companies are likely benefiting from a cut in Social Security taxes that may boost consumer spending, and a tax break for companies that purchase new machinery and other big-ticket items, analysts said. Both tax breaks took effect last month.

Consumers are spending more on autos, appliances and other goods, while businesses have invested in more industrial machinery and computers. Those trends boosted economic growth to a 3.2 percent pace in the October-December quarter, the Commerce Department said last week.

Duesterberg said orders for mining and drilling equipment and for airplanes and airplane parts are also rising.

Factories' healthy pace of expansion is likely to continue in the coming months. Manufacturing firms surveyed by ISM said their backlog of orders jumped in January, pushing an index measuring that activity to 58 from 47.

U.S. factories are also benefiting from rising overseas sales. The index of export orders jumped to 62 in January, from 54.5 the previous month. That matches a recent peak reached in May and is otherwise the highest level for that index since December 1988.

The employment index rose to its highest level since 1973, a sign that manufacturing companies are hiring more workers. But Duesterberg cautioned that the ongoing boom in productivity in manufacturing would likely limit hiring. Industrial companies have boosted output for decades even as their overall levels of employment have declined.

And the prices paid index, which measures whether manufacturing companies are paying more for raw materials, jumped sharply. That's a sign that inflation could pick up soon. If manufacturers are unable to pass on the higher costs, it could cut into their profit margins.)